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Redesigning 401(k) Match Can Spur Workers to Save

Companies can encourage employees to save more in 401(k) plans by spreading the company match over a bigger portion of employees' contributions, according to a recent analysis by Principal Financial Group.

Principal's examination of its contracts for 6,560 defined-contribution plans found that when companies match 100% of the first 2% of pay saved, employees on average contribute 5.3% of their pay. Companies that match 50% of up to 4% of pay saw an average contribution rate of 5.6%, while those matching 25% of up to 8% of pay had an average contribution of 7% of pay.

"The employer match is a great motivator in spurring better retirement savings behavior," says Barrie Christman, vice president of individual investor services at Principal. "By stretching the match formula, the savings rate improves at no additional cost to the plan sponsor."

However, companies' current practices run counter to the Principal's recommendation. Aon Hewitt's data show just 11% of companies provide a match on more than 6% of pay, says Rob Reiskytl, a principal in Aon Hewitt's retirement consulting practice.

Traditionally, the most popular match was 50% of up to 6% of pay, Reiskytl says. As the number of defined-benefit pension plans declined, many companies moved to bolster their 401(k) match, and while the most common is still 50% on 6%, 100% on 6% is now a close second, followed by 100% on 4% and 100% on 5%, Reiskytl says.

The fact that most companies don't match on contributions exceeding 6% of pay in part reflects inertia, he says, as well as government safe harbor regulations, which say 401(k) plans can avoid nondiscrimination testing to ensure the plan doesn't favor highly paid employees by following certain guidelines, one of which is that the company match should apply to no more than 6% of pay. "The migration toward 6% and not above 6% is being influenced by government regulation," Reiskytl says.

In fact, he says, 401(k) plan participants should be saving a far higher portion of their salaries than 6%. An Aon Hewitt analysis of 2 million workers that took into account their access to other sources of retirement income, such as Social Security and pension plans, found that to ensure a comfortable retirement, on average, employees should be saving roughly 13% to 14% of their pay.

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